The cap you are shown is usually set for the first term only: of 99 fixed index annuities with a published minimum, 86 let the insurer lower the cap to 1.00% or less, and the median 2026 S&P 500 one-year cap was 8.12% against a median contractual minimum of 1.00% (RLF, FIA Guaranteed Minimum Caps, October 4, 2026).
What a fixed index annuity is, in plain words
A fixed index annuity is a contract with an insurance company. You deposit money, and the insurer credits interest based partly on how a stock market index, such as the S&P 500, moves over a set period, usually one year. You do not own the index or the stocks in it.
If the index falls, the interest credited for that period is usually zero, not a loss. If the index rises, you get only part of the gain. The insurer decides how big that part is, using a cap, a participation rate or a spread (SEC, Updated Investor Bulletin: Indexed Annuities, July 31, 2020).
- Cap: the most you can be credited. With a 7% cap and a 12% index gain, you get 7%.
- Participation rate: the share of the gain you get. At 75% participation and a 10% gain, you get 7.5%.
- Spread: a percentage subtracted from the gain. With a 3% spread and a 9% gain, you get 6%.
Those three examples are the SEC's own (same source). Fixed index annuities are regulated as insurance by your state insurance department. Registered index-linked annuities, which can lose money when the index falls, are securities regulated by the SEC and FINRA (FINRA, July 14, 2022). For variable annuities, see our variable annuity page. For the basics, see fixed index annuity explained.
How it is usually described, and what the contract says
The pitch is often some version of "market upside with no downside" or "you can't lose money." The contract tells a narrower story.
The cap is not fixed. Indexed annuity contracts commonly let the insurer change the cap and similar features from time to time, and those changes can affect your return (SEC investor bulletin, July 31, 2020; FINRA, The Complicated Risks and Rewards of Indexed Annuities, July 14, 2022). Most insurers review caps, participation rates and spreads regularly, often monthly, and weigh investment yields, option costs, competition and profit objectives (American Academy of Actuaries, Fixed Indexed Annuities: Product Mechanics and Risk Management, February 2026, p. 25). The only limit is the minimum printed in your contract. Our minimum caps study and who decides your renewal cap show how low those minimums go.
Dividends are usually left out. Index gains are generally measured on price alone. In the SEC's example, an index with a 7% total return, 2.5% of it from dividends, counts as 4.5% for crediting (SEC investor bulletin, July 31, 2020).
"No fee" does not mean no cost. The SEC notes that caps, participation rates and spreads can reduce your return the same way a direct fee would, even when the annuity is called "no fee" (same source).
You can lose money, just not from the index. Surrender charges commonly apply for 6 to 10 years or longer, and withdrawing early can cost part of your principal (SEC investor bulletin, July 31, 2020; FINRA, July 14, 2022). A market value adjustment (MVA) may also raise or lower what you get on early withdrawals (American Academy of Actuaries, February 2026, p. 5). And a contract that credits 0% in a year when prices rose 3% has lost buying power.
The real trade-offs, with numbers
What is guaranteed. State nonforfeiture law sets a floor for the surrender value: under the national model law it is built from at least 87.5% of the premiums paid, accumulated at an interest rate between 0.15% and 3% set by a Treasury-based formula (NAIC Model 805, Standard Nonforfeiture Law for Individual Deferred Annuities, Fall 2020, Section 4). That floor protects against a total loss. It also means the guaranteed value of a $500,000 deposit can start near $437,500, not $500,000.
Complexity. Crediting methods vary (annual point-to-point, averaging, monthly caps and others), and FINRA notes that the variety makes it hard to compare one indexed annuity with another (FINRA, July 14, 2022).
Seller pay. In the most recent public industry averages RLF could verify, indexed annuities paid the highest average commission among fixed annuity types (RLF, Annuity Commissions, October 3, 2026). That cost is usually built into the caps and surrender schedule rather than taken from your deposit. Ask what the seller earns, in dollars.
Taxes. Interest grows tax-deferred, but it is taxed as ordinary income when withdrawn, even though it is linked to a stock index. Withdrawals before age 59½ may also face a 10% federal tax penalty (SEC investor bulletin, July 31, 2020). See how annuities are taxed and check with a tax professional.
When a fixed index annuity can make sense
To be fair, the product does some things well. It removes index losses from the crediting, which can matter to someone who would otherwise sell in a downturn. It defers tax on interest in a taxable account. And over a full surrender period it can earn more than a fixed contract in years when the index rises, as long as the caps stay reasonable.
It tends to fit best when the money will not be needed for the whole surrender period, the buyer has other savings for emergencies, and the buyer has read the minimum cap, participation rate and spread for every strategy and is comfortable with the low end. If you mostly want a known rate, a multi-year guaranteed annuity or a CD may be simpler to compare (see annuity vs CD).
How to check before and after you sign
- Ask for the disclosure document and Buyer's Guide. Under the national model rule, if they are not given at or before the application, you get a free look of at least 15 days (NAIC Model 245, Annuity Disclosure Model Regulation, Summer 2021, Section 5). Your state may give more; see the free-look period.
- Look up the insurer and its complaint record with NAIC Consumer Insurance Search and confirm the seller's license with your state insurance department.
- If the product is a registered index-linked annuity (a security), check the seller on FINRA BrokerCheck.
- Each year, compare the renewal cap with the first-year cap and the contract minimum. Before the surrender period ends, decide on purpose whether to stay. See surrender charges.
A plain example with numbers
All figures are hypothetical. They show the arithmetic of a cap cut, not a forecast. Assume a $500,000 deposit, annual point-to-point crediting, a 0% floor, and these index price changes (dividends excluded): +12%, -8%, +15%, +6%, +10%.
| Year | Index price change | Credited, cap stays 8% | Credited, cap cut to 4% after year 1 | Credited, cap cut to 1% minimum |
|---|---|---|---|---|
| 1 | +12% | 8% ($40,000) | 8% ($40,000) | 8% ($40,000) |
| 2 | -8% | 0% ($0) | 0% ($0) | 0% ($0) |
| 3 | +15% | 8% ($43,200) | 4% ($21,600) | 1% ($5,400) |
| 4 | +6% | 6% ($34,992) | 4% ($22,464) | 1% ($5,454) |
| 5 | +10% | 8% ($49,455) | 4% ($23,363) | 1% ($5,509) |
| Value after 5 years | $690,832 if you held the index at price only | $667,647 | $607,427 | $556,363 |
The arithmetic: each year's credit is the lower of the index change and the cap, never below 0%, applied to the prior value. In year 3 at an 8% cap, $540,000 times 8% is $43,200. At a 4% cap it is $21,600.
Same index, same deposit: the difference between keeping the first-year cap and a cut to the contract minimum is $111,284 over five years. A direct index holder would also have had dividends, but would have taken the year 2 loss and had no floor. The 1% column is the low end that many contracts allow, which is why the minimum is the number to ask about.
Red flags
- "You can't lose money" said without mentioning surrender charges, a market value adjustment or rider fees.
- A brochure or illustration that shows only the current cap and never the guaranteed minimum cap.
- An illustration that leads with a back-tested period of strong index years.
- Calling the product "no fee" when caps, participation rates or spreads limit your return.
- Describing returns as "market returns" without saying dividends are excluded.
- A surrender period of 10 years or longer for money you may need sooner.
- Pressure to move money from a CD, a multi-year guaranteed annuity or another annuity still in its surrender period.
- Comparing the annuity's best case to a bank's worst case instead of comparing minimum guarantees.
- Unwillingness to show the renewal cap history for existing owners of the same product.
- A new, untested index or volatility-controlled index chosen because it illustrates well.
- Reluctance to tell you, in dollars, what the seller earns on the sale.
Questions to ask before you sign
- What is the cap, participation rate or spread on each strategy today, and how long is it guaranteed?
- What is the minimum cap, minimum participation rate and maximum spread written into my contract?
- What has the renewal cap been for people who bought this product in each of the last five years?
- Does the index exclude dividends, and is it a volatility-controlled index?
- How long is the surrender period, and what is the charge in each year?
- Is there a market value adjustment, and how could it change what I get back?
- Is there a bailout provision that lets me leave without a charge if the cap drops below a set rate?
- What is my guaranteed minimum surrender value at the end of each year?
- What would I earn in a multi-year guaranteed annuity or CD for the same term, and why is this better for me?
- What do you earn on this sale, in dollars, and on a shorter-term version?
- How long is my free-look period in my state, and how do I use it?
Read This Before You Sign
A one-page checklist: the red flags in annuity and indexed universal life (IUL) sales, and the questions to ask before you sign anything. Questions to ask about caps, minimums, surrender charges and seller pay before you sign a fixed index annuity. We’ll email it to you.
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Sources
- SEC Office of Investor Education and Advocacy: Updated Investor Bulletin: Indexed Annuities (July 31, 2020)
- FINRA: The Complicated Risks and Rewards of Indexed Annuities (July 14, 2022)
- American Academy of Actuaries: Fixed Indexed Annuities, Product Mechanics and Risk Management (February 2026)
- NAIC: Model 805, Standard Nonforfeiture Law for Individual Deferred Annuities (Fall 2020)
- NAIC: Model 245, Annuity Disclosure Model Regulation (Summer 2021)
- Retirement Literacy Foundation: FIA Guaranteed Minimum Caps (October 4, 2026)
- NAIC: Consumer Insurance Search (checked October 14, 2026)
The Retirement Literacy Foundation is a 501(c)(3) public charity. This page is general education, not tax, legal or investment advice. Nothing is sold here, no product is recommended, and RLF accepts no funding from financial companies. Rules and figures change; each one above shows its source and date. Check anything you plan to act on with your state insurance department or a qualified professional who is not paid on the product.